It was an honor to catch up recently with long-time Private Equity Portfolio Manager Scott Parrish of the State of Wisconsin Investment Board (SWIB).
We were able to discuss where the fund has been with respect to sourcing managers and what the future holds for SWIB, which is the ninth largest public pension fund in the U.S. and the 25th largest pension fund in the world. Parrish and his teammates manage assets on behalf of about 650,000 current and former employees of Wisconsin’s state agencies and most local governments as participants other than the City of Milwaukee and Milwaukee County. There are 1,500 state and local employers represented in this pool.
Parrish joined SWIB in 2005 and became a portfolio manager in 2006. Prior to that he served as an investment officer at the Teachers’ Retirement System of Illinois.
Currently, SWIB totals $129 billion in assets and approximately 91%, or $117 billion, comprise the two Wisconsin Retirement System (WRS) Trust Funds. The $108 billion Core Fund includes holdings in global stocks, bonds, real estate and private equity, and the $8.7 billion Variable Fund is an optional stock fund portfolio.
WRS trust funds made headlines as they grew by almost $16 billion in 2019 due to SWIB generating a net return of 19.33%.
Von Bevern: Thank you for agreeing to share your insights with us at this unprecedented time, Scott. How would you characterize current institutional LP behavior around private equity allocations and portfolio target adjustments at this time of uncertainty?
Parrish: Thank you for having me, Michael.
The current volatility in valuations for both public and private assets is causing problems for institutional LP private equity allocations.
When the Q1 2020 public markets were down -20%, this presented a denominator problem as private equity values for Q4 2019 were up 5%. Institutional LPs that were at or near their private equity allocation targets at the end of 2019 found themselves overallocated by the end of Q1 2020. This could lead LPs to sell funds in the secondary market to get back to their allocation targets.
However, LPs could not sell assets in Q2 2020 because secondary buyers demanded significant discounts due to the large decline in the public markets during Q1 2020 that had not yet been reflected in the pricing of the private market assets. There was even further volatility when Q1 2020 private equity financial statements were released with the market values down -10% at the same time the public markets had significantly rebounded in Q2 2020 with a return of 20%. Those LPs that were above their private equity allocation targets at the end of Q1 2020 found themselves at or below their allocation targets at the end of Q2 2020.
SWIB currently has a 9% allocation target for private equity (which also includes venture capital and private debt). Our private equity allocation floats (+/- 3%), which allows us to handle volatility like what occurred during the first six months of 2020.
SWIB’s Private Equity Portfolio focuses on annual dollar commitments (vintage year pacing) versus a percentage target. By focusing on vintage year diversification and having a flexible allocation target, SWIB’s Private Equity Portfolio (team) doesn’t have to worry about overcommitting in any given year or having to sell assets at the wrong time to maintain a specific allocation target.
Von Bevern: Please speak to SWIB’s current stance toward first time funds vs. follow-on investments.
Parrish: SWIB has continued to stay active in 2020 by committing capital to both existing and new GPs. For those situations where SWIB committed to a new GP relationship, the Private Equity team had already begun its due diligence review prior to working remotely in mid-March. Our focus on new relationships is on the lower end of the market (small buyout and growth equity). We’re looking for sector specialists that can generate outsized returns for the Private Equity Portfolio.
Von Bevern: SWIB has developed a comprehensive risk and operational build out, in tandem with the right outsourced provider(s) in many cases. Please speak to how essential such systems are during times of great market dislocation, like what we’ve been seeing this year starting in March.
Parrish: I’ve been pleasantly surprised with how well the Private Equity team has been working remotely since mid-March.
Our group has become experts in using Microsoft Teams as we have daily interactions, weekly staff meetings and present investment recommendations through video calls. There are over 75 core GP relationships in SWIB’s Private Equity Portfolio, and the team has been able to have video meetings or phone calls with nearly all the GPs since mid-March.
Several of the GPs have held Annual Meetings and Advisory Board Meetings via Zoom and we expect all the upcoming meetings in the fall will be held virtually as well. We’re currently implementing a new Private Equity Accounting and Portfolio Reporting System (eFront). Having a system that handles the cash flow processing (capital calls and distributions) has been a huge asset during this time of working remotely.
Von Bevern: How are U.S. institutional allocators grappling with challenges faced by the inability to travel and meet managers in person? How common is the is the ‘all virtual’ allocation, whereby an LP deploys capital without ever meeting a GP in person?
Parrish: This is a popular conversation topic for SWIB’s Private Equity team. As I mentioned, video calls with GPs are becoming the norm and are expected to continue in the foreseeable future.
Given that we don’t know how long working remotely is going to last and when it will be feasible to travel to meet with GPs in their office, we must address virtual due diligence reviews. There may be some situations where SWIB does not move forward with a commitment through a virtual review and other situations where SWIB gets comfortable moving forward with a commitment through a virtual review.
In either situation, the due diligence review becomes even more important as we are not able to meet in-person with the GPs nor physically visit the office. Virtual diligence reviews are easier for existing GP relationships as we have had multiple meetings with those GPs.
For prospective GPs where we can’t meet in person, we need a greater level of comfort around both investment and operational due diligence. This process may require (i) multiple video calls with numerous members of the GP; (ii) more off-sheet reference calls; (iii) additional analysis on the underwriting and future outcomes of existing portfolio companies; (iv) tougher negotiations on the legal agreements to provide greater downside protection; and (iv) a smaller commitment from SWIB that is able to grow in subsequent funds.
Thank you again for having me, Michael.